Global Financial Sector Reform: An Unfinished Agenda by Christine Lagarde, Managing Director, International Monetary Fund

October 25, 2012

by Christine Lagarde
Managing Director, International Monetary Fund
Toronto, October 25, 2012

As prepared for delivery

Chers amis, dear friends, bonsoir/good evening. I am very pleased to be here in Toronto and honored to be a part of this Gala event tonight.

Let me first extend thanks to Jim Balsillie, Jennifer Jeffs and other members of the Board of Directors at the Canada International Council. I am honored to be recognized by the CIC tonight. The Council promotes the very goals and spirit of internationalism that have guided my career choices and my own personal beliefs.

Let me also thank Governor Carney for his kind words. I have had the privilege of working closely with Mark, previously in the G-7 and G-20, as a colleague at the FSB, and now at the IMF. Canadians are fortunate to have such a leader at their service. The rest of the world is also benefiting from his wise counsel at the Financial Stability Board (FSB). So thank you, Canada, for sharing Mark’s talents with us.

One of my last visits to Canada was to Iqaluit in February 2010 to attend a G-7 Finance Ministers’ meeting. Putting in place a safer financial sector was a key topic of discussion then―aside from the sub-zero temperatures! It is warmer this time round, and likewise, we are a bit closer to putting in place a safer financial system.

However, we are not there yet.

If we are to strengthen the global financial sector to make it truly safe for the future, then we must do so as “globalists”.

Tonight I would like to focus on three issues:

1. the global outlook and the financial sector’s contribution;

2. the progress made towards a safer financial system; and

3. the unfinished reform agenda.

It is fitting to discuss these topics in Canada, a country with one of the strongest financial sectors in the world. While it faces its own challenges, there are important lessons that Canada can teach the rest of the world about how to build a stronger, safer financial system.

As policymakers, we must push through reforms today to create the system we need for the future. To quote your most famous hockey player―Wayne Gretzky: “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be”.

1. The global economic and financial outlook

The global recovery has suffered new setbacks and growth has been disappointing. Output is contracting in the euro area and growth has decelerated in many other countries. The IMF projects global growth at 3.3 percent in 2012 and 3.6 percent in 2013; in advanced economies, output is projected to expand by only 1.3 percent this year and 1.5 percent next.

Growth is being supported by accommodative monetary policy, but held back by weak financial systems, fiscal consolidation, private sector deleveraging, and policy uncertainty.

A further escalation of the euro area crisis and the fast-approaching U.S. “fiscal cliff” are the key downside risks and sources of this policy uncertainty.

It was against this backdrop that I met with policymakers in Tokyo two weeks ago for the 2012 World Bank-IMF Annual Meetings. While discussions were complex, we came away with a clear commitment to act now to lift this debilitating uncertainty, and also a commitment to take stock publicly of our performance next spring.

This will be an essential deliverable because, to date, policies in the major advanced economies have not been sufficient to rebuild confidence, and the world’s financial system is still not functioning well.

In many countries, banks are still weak. As a result, many borrowers still face very tight borrowing conditions. This is the adverse feedback loop of credit tightening on growth.

In Europe, a pullback of cross-border private capital flows has driven up funding costs in the periphery for all borrowers, and the effect on growth is causing pain across the continent.

For this reason, I welcome the call last week by euro area Leaders to adopt a legal framework for a single supervisory mechanism by end 2012 and provisions on national resolution and deposit guarantee frameworks. We look forward to more details about the scope of this new Supervisor and to more news about direct bank recapitalizations.

For now though, the financial sector―the source of this crisis―is holding down the recovery in key parts of the global economy. Considering the staggering economic and human costs over the past six years, we must do whatever it takes to make sure this does not happen again.

2. The road to financial sector utopia: paved with good intentions

Moving to financial sector reform, what did we set out to achieve five years ago to build a safer financial system?

Starting in 2008, and reinforced in 2010 in the G-20 Toronto Declaration, we all agreed on the need for a safer system, a structure that would be more transparent, less leveraged, better capitalized, and more liquid. We would have a better understanding of the nonbank sector and about how to resolve those very large institutions that are “too big to fail”.

This system would reduce the severity of boom-bust cycles and the burden of distress on taxpayers. It would serve businesses and households better, not just itself.

Five years later, where do we stand? The good news: there have been some major achievements in regulatory reform since the 2008 G-20 Washington Declaration.

The biggest advance is the new capital and liquidity requirements for banks under Basle III, which has even higher standards for systemically important banks. Recent IMF research shows that higher buffers, like those proposed in Basle III, are also associated with higher rates of growth and lower economic volatility.

There has been also good progress―led by the FSB―on developing a new standard for the resolution of banks and on a commitment to improve the supervision of the biggest institutions.

In addition, countries made commitments to reduce risks in the over-the-counter derivatives markets. Consensus was also forged by regulators on compensation practices and better governance of banks.

Collaboration between the G-20, the FSB and the IMF has been an integral factor in moving the agenda forward. We have been strong proponents of the reforms and have participated actively in discussions on design, implementation and impact.

The IMF has also played a central role in the development of new approaches to identifying and managing “big picture” risks, what we now call macroprudential policies. These are system-wide risks related to the economic cycle, market structures, and to individual institutions.

Canada has been a leader in this area, implementing macroprudential policies to rein in the build-up of household debt, such as lowering debt service-to-income ratios and increasing down payments on new mortgages.

All of these new reforms comprise the tools so far that will help us shape the future financial system. We must shape the system so it cannot again hold us ransom to the consequences of its failings. As Marshall McLuhan said, “We shape the tools, then the tools shape us”.

The question is, are these new rules and principles being implemented? Are they working?

The IMF recently assessed reform progress. We found that reforms are heading in the right direction, but they have not yet delivered a safer financial system.

While fundamental changes do take time, the basic structures that we found problematic before the crisis are still with us. Systems are still overly complex; banking assets are still highly concentrated with strong domestic bank interlinkages; some institutions continue to rely excessively on wholesale funding; and many institutions are still too-important-to-fail.

What is holding back further progress?

Change is not visible yet, in part because implementation is being delayed in some places, intentionally or unintentionally, and because some reforms are meeting resistance.

First, some financial systems are still under distress and crisis-fighting efforts are inadvertently impeding reforms. In addition, reforms like Basle III have built in generous implementation timetables, precisely to allow the economy to recover.

Second, there are many vested interests working against change and pushback is intensifying. It is interesting how some banks say the new regulations will be too burdensome, but then spend hundreds of millions of dollars lobbying to kill them! I would agree with Governor Carney that the idea of watering down reforms because of concerns about costs is “fanciful”.

Fund staff recently conducted a study on the costs of regulatory reform and found that the likely long-term increase in borrowing costs would be about one quarter of one percentage point in the U.S., and lower elsewhere.

Well, here we are in the sixth year of crisis, with more than 200 million people around the world out of work. Some estimates put GDP in the US and Europe at about 10-15 percent lower than what it would otherwise have been. Not sure about you, but I would say that the return is well worth the investment.

If implemented―these reforms will eventually deliver a more stable system, but the political cycle and pressure for delays are affecting policy momentum.

3. The unfinished reform agenda: still work to do!

Moving to my third point then, the unfinished reform agenda. Most countries have committed to adopt some or all of the new regulations, and some have moved further ahead with their own national policies.

The challenge now is to proceed to the end of the reform path all together. The job of the FSB, the IMF, and members like Canada, is to push it through to its productive conclusion. What do we need?

  • To start, we need concrete progress with the too-important-to-fail conundrum. We need a global level discussion of the pros and cons of direct restrictions on business models. For example, the Volcker Rule in the U.S., the Vickers Commission proposals in the U.K., and the Liikanen Report on the EU banking system will have important effects beyond their jurisdictions. Here a global perspective is sorely needed.
  • We also need further progress on recovery and resolution planning for large institutions, especially cross-border resolution. Much work is underway to develop the tools to intervene in distressed institutions, but we need to move to compliance and assessment on an international scale.
  • “Shadow banking” remains a concern. This is activity by nonbank financial institutions operating outside the regulatory perimeter. The FSB is looking into this and we look forward to collaborating closely with them on follow up.
  • For the remainder, the key word at this stage is implementation: implementation of derivatives markets reform, so these can become truly “over the counter” and not “under the table”; implementation of the FSB’s principles for compensation; and most importantly, implementation of the Basle Committee’s principles for effective banking supervision. Even the best rules are of no value if not implemented and well supervised.

Global agenda needs collective action and strong leaders

A robust recovery will only last if supported by resilient institutions and markets. Indeed, let us not forget the end goal here: a safe financial system to support sustainable growth. Moreover, there is simply no alternative: the costs of crisis are so much higher than the costs of building a more stable system.

This is a truly global challenge, one well suited to tonight’s celebration of “globalism”. It is also a fitting topic to discuss here in Canada, with its history and culture of multilateralism.

You can speak with credibility based on your own financial sector success, but you are also regarded as a leading multilateralist. Abroad, Canada is identified by its values of coordina-tion and consensus building, which have given your country influence beyond its years.

During his ground-breaking work in international diplomacy and peacekeeping, your Prime Minister Lester B. Pearson said: "We must keep on trying to solve problems, one by one, stage by stage, if not on the basis of confidence and cooperation, at least on that of mutual toleration and self-interest."

Building a safe and stable financial system is in the best interests of the global community, but it also serves the self-interest of nations.

We count on your continued support in this endeavor.

Thank you


Public Affairs    Media Relations
E-mail: E-mail:
Fax: 202-623-6220 Phone: 202-623-7100